Sunday, 25 August 2013

Why is it that the expression "third way" always worries me?

 In the latest issue of "Insights" from the New Zealand Institute Jason Krupp argues for A third way on asset sales.

Krupp argues that
The anti-privatisation camp, rightly or wrongly, have taken glee in pointing out that the Government is selling off assets that generate higher dividend returns than the equivalent interest rate on our public debt.
If true, then it just tells us that the method of sale is wrong, the government is not capturing the full amount of money it could if it used a different method of sale. Answer, change the method of sale.

Also Krupp says,
Critics have also noted retail investors will be paying for these assets twice, since they’re technically owned by all New Zealanders anyway. Plus, those who don’t participate are having part of their national wealth snatched away from them.
This is just plain wrong, New Zealanders do not own the SOEs. Oliver Wendell Holmes Jr. asks the question: What are the rights of ownership? His answer,
They are substantially the same as those incident to possession. Within the limits prescribed by policy, the owner is allowed to exercise his natural powers over the subject-matter uninterfered with, and is more or less protected in excluding other people from such interference. The owner is allowed to exclude all, and is accountable to no one. (The Common Law, p193, (1963 edn.))
Clearly the "public" does not have the rights Holmes refers to, he government (or its bureaucracy) has them. Following Grossman and Hart ("The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration", Journal of Political Economy, 94: 691-719) economist's tend to define the owner of an asset as the one who has residual rights of control over the asset; that is whoever can determine what is done with the asset, how it is used, by whom it is used, when they can use it etc - note that ownership is not defined in terms of income rights. Under "public" ownership it isn't the "public" who has the control rights, its the government. The "public" can not determine what use is made of a "public" asset, rather its use is determined by the politicians and managers in command of it.

Madsen Pirie at the Adam Smith Institute blog puts it this way
The state sector may have the name of the public filled in on the dotted line, but the public do not own it in any meaningful sense of the word. All of the attributes of ownership, such as control, the right to determine what use is made of it and under what conditions, is determined by the bureaucracy in command of it.
Because the public has no choice over whether to pay for state services, or to choose what quality of service is appropriate for them, they have no power over them. In their absence it is the managers and workforce who increasingly direct the services to meet their needs and convenience instead of those of the public.
Krupp continues,
Indeed, it could be argued that the efficiency drag of a single shareholder [the government] can already be seen, with Contact Energy and TrustPower (two private companies with diverse shareholder bases) offering the highest returns on equity in the sector. Returns from the state-owned firms lag behind these two companies by a noticeable margin, even though they’ve been operating as private entities for over a decade.
The issues here isn't so much that there is a single shareholder, its that the shareholder is the government. A firm with a single private shareholder would act differently from the SOEs. This is one reason for not liking partial privatisation, the government keeps control with its 51%.

If you look at the economics literature you will find that fully private companies outperform mixed ownership firms. Some insight on this is offered by a recent paper in the Scottish Journal of Political Economy (Volume 59, Issue 1, pages 1–27, February 2012). The paper "What Drives the Operating Performance of Privatised Firms?" by Laura Cabeza García and Silvia Gómez Ansón argues that the greater the amount of privatisation the better the performance of the firm. Not an entirely surprising result as the full force of market discipline can only be applied if the firm is fully in private hands but it is something for the government to keep in mind. It would suggest that any performance improvements due to the government's partial privatisation plans will be modest. The abstract reads,
Using a panel data analysis of Spanish privatised firms, we study how different factors influence the operating performance of divested companies. The results show that it is not privatisation per se but other factors that matter. After controlling for possible sample selection bias related to government timing of divestments, we find that the greater the relinquishment of State control and the smaller the percentage of ownership held by managers and/or employees, the better the firms’ post-privatisation performance. Moreover, privatisations that are accompanied by liberalisation programmes and occur during buoyant economic cycles turn out to be more successful. (Emphasis added)
When you look at the performance of mixed ownership firms they don't do as well as fully privately owned firms. For example, Aidan Vinning and Anthony Boardman in "Ownership and Performance in Competitive Environments: A Comparison of the Performance of Private, Mixed, and State-Owned Enterprises", Journal of Law and Economics vol. XXXII (April 1989) conclude
'The results provide evidence that after controlling for a wide variety of factors, large industrial MEs [mixed enterprises] and SOEs perform substantially worse than similar PCs [private corporations].'
So fully private firms out-perform mixed ownership firms.

Krupp then asks,
So, given these compromises, has the hybrid privatisation been worth it?
In my view there are at least 6 reasons for thinking hybrid privatisation will not be worth it:
  • First, selling only 49% of the shares in the companies is unlikely to make a huge difference to the way the SOEs are run. In particular the sell off will not make the firms any more efficient since the government will still be the controlling shareholder.
  • Second, if the government really does want to maximise the income it gets from the sales selling 49% is not a good idea. 51% is worth a lot more than 49%, that is people will pay a premium for control.
  • Third, selling to "Mums and Dads" will do nothing for the amount of money raised, since Mums and Dads will need a discount to make them buy shares.
  • Fourth, selling to "Mums and Dads" will do nothing for the efficiency effect of having private owners, since there will be too many "Mums and Dads" for them to be able to coordinate their effects to effect the firm's behaviour.
  • Fifth, given that each "Mum or Dad" will own only a very small share of any of the firms, they have little incentive to become informed on the firm's activities since they will only capture a very small amount of any improvement in performance they could bring about. This is another reason why performance is unlikely to change.
  • Sixth, the discipline of bankruptcy or takeover is not greater since the government is still the controlling shareholder and is unlikely to let either of these options happen.
Krupp ends by saying,
Frankly, it’s too early to tell, but it’s interesting to consider that there could have been a third option: just giving the shares away (as pointed out by Professor Sinclair Davidson of the Royal Melbourne Institute of Technology).

While the government would give up a dividend stream, that’s traded off against the $10 billion it would inject into the economy at a local level.

It also scratches two other important itches; it instantly creates 4.4 million equity investors, and removes the political temptation to win votes by blow-out spending, knowing you can sell off parts of the balance sheet when the debts come due.
It should be noted that giving shares away has been used before, especially in the old Soviet Union, but its not clear that its outcomes where that successful. You also have to ask, Why do we want "4.4 million equity investors"? What we want is an ownership structure that results in the most efficient use of our resources, How can we know that having "4.4 million equity investors" is that structure? I'm guessing that most people would not want their shares and thus would simply sell them which results in fewer than "4.4 million equity investors", which seems to defeat Krupp's aim of creating these investors in the first place. All it would do is change who gets the rewards from selling the shares. This may, or may not, be a good thing.

As to the aim of removing the "political temptation to win votes by blow-out spending", selling 100% of the SOEs by any means would mean that this is at best a one-off trick.

All in all its not clear that the third way is the right way.

1 comment:

Overtech said...

Dear Anti-Dismal:

I enjoyed the article, and you raise many valid points, though some of the positions you attribute to me are a little off.

Firstly, it's the critics of the mixed ownership who've claimed New Zealanders already own the state owned assets. In fact I remember a particular dinner conversation in which one guest said of the partial float “why should I pay for what’s already mine?”.

As for the complicated morass of property rights, democracy and the nature of general elections versus specific referenda, well, I’m sure you’ll agree that it’s too broad to tackle in the 500 words I had to work with.

Also, in a piece of this nature you have to take a few short cuts, such implying Government ownership when referring to a single shareholder. Should I have spelled it out?
Perhaps, but I’m giving the reader the deductive benefit of the doubt – one I’m confident they’ve made.

This need for short cut extends to the share ownership issue you’ve taken umbrage with. Of course we won't have 4.4m shareholders for long as some will sell and some will hold because there is a free market to sell them - something that wasn't available in the Soviet example you used.

But those who sell can use those funds for other things – investing in a business, paying down debt, splashing out at the shops – which have upside benefits for the economy and the government’s coffers.

And adding millions of people to the shareholder roll is a good on many levels. It’s a fantastic way of building up knowledge in the equity market, which we need if we are going to foster a savings culture in New Zealand.

I’m sure you’d also agree that a thriving equity market (which we don’t have at the moment, but it’s getting better) is essential if we’re going to lower the cost of capital for New Zealand businesses, which is notably higher than across the Tasman.

Lastly, “selling 100 per cent of the SOEs by any means would mean that this is at best a one-off trick” is exactly the point, albeit a Hayekian one. If, as a politician, you know you can’t sell the family silverware to get you out of debt, you’re likely to think a bit more carefully about what you’re getting into debt for (actually that might be a little naive).

In conclusion, you’re right, the third way is not that clear at all, but equally neither are the benefits/costs of other options.

Jason Krupp

The New Zealand Initiative